Hedge Funds' Yen Bet Backfires as Currency Plunges

Hedge funds' bullish stance on the Japanese yen (JPY) has turned sour as the currency experienced its sharpest decline in 15 years. The funds' positioning in yen-denominated assets influenced their decision to turn bullish, but the currency's recent plunge has left them nursing significant losses.

The Bank of Japan's (BOJ) monetary policy played a significant role in hedge funds' bullish stance on the yen. The BOJ's decision to raise interest rates for the second time this year led to an appreciation in the yen, making yen-hedged funds less attractive compared with their unhedged rivals. This move also hammered investors who had been borrowing the lower-yielding yen to invest in higher-yielding assets denominated in other currencies, a strategy known as a carry trade.

The divergence in interest rate paths between the U.S. and Japan also impacted hedge funds' yen positioning. The U.S. Federal Reserve is expected to cut rates, while the BOJ is likely to continue raising rates, making the yen a more attractive investment. However, the recent decline in the yen has caught many hedge funds off guard, highlighting the volatility of the currency and the risks associated with carry trades.

The unwinding of the yen carry trade has contributed to the currency's sharp depreciation, leaving hedge funds with significant losses. The situation is unusual, and there are still concerns that further losses could be on the horizon. As a result, investors are considering a "50-50" approach, allocating half of their assets to currency-hedged funds and the other half to unhedged funds.

The recent decline in the yen has raised questions about the wisdom of maintaining a currency hedge in Japan-focused equity ETFs. While currency-hedged funds like the WisdomTree Japan Hedged Equity Fund (DXJ) have outperformed their unhedged peers in the past, the recent move by the BOJ has made them less attractive. Investors are now considering whether to remove the currency hedge and invest in cheaper unhedged funds, such as the Franklin FTSE Japan ETF (FLJP) and the JPMorgan BetaBuilders Japan ETF (BBJP).

In conclusion, hedge funds' bullish stance on the yen has backfired as the currency experienced its sharpest decline in 15 years. The BOJ's monetary policy and the divergence in interest rate paths between the U.S. and Japan influenced hedge funds' positioning in yen-denominated assets. The unwinding of the yen carry trade has contributed to the currency's depreciation, leaving hedge funds with significant losses. As a result, investors are considering a more balanced approach to investing in Japan-focused equity ETFs, weighing the benefits of currency hedging against the costs.